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Structural Breaks, Dynamic Correlations, Volatility Transmission, and Hedging Strategies for International Petroleum Prices and U.S. Dollar Exchange Rate

Walid Mensi, Shawkat Hammoude () and Seong-Min Yoon ()

No 884, Working Papers from Economic Research Forum

Abstract: This paper investigates asymmetric volatility spillovers, forecasts and portfolio diversification between the USD/euro exchange market and each of the major spot petroleum markets of WTI, Europe Brent, kerosene, gasoline and propane, using the bivariate exponential GARCH (EGARCH) model. The results provide evidence of significant asymmetric volatility spillovers between the U.S. dollar exchange rate and those petroleum markets. Moreover, we conclude that the persistence of volatility in all paired exchange ratepetroleum markets declines when structural breaks are controlled for in the model. Moreover, integrating the information concerning the structural breaks in this model improves the accuracy of the estimates of volatility dynamics and future volatility forecasts. Additionally, we analyze the optimal portfolio weights and hedge ratios based on the estimates of the bivariate EGARCH model with and without the structural breaks to demonstrate the relevance of our empirical results to investors in terms of developing appropriate hedging and asset allocation strategies. Thus, the findings have important implications for financial risk management, portfolio diversification, and monetary and fiscal policy operations for oilexporting and -importing countries.

Date: 2014-12, Revised 2014-12
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